1. (SBU) SUMMARY: At the ten-year anniversary of the 1997 financial
crisis, Thailand faces economic challenges of a much different
nature. Gone are the days of easy loans fueling massive real estate
speculation and luxury imports. Rather than fighting a currency
devaluation, and exhausting its foreign exchange reserves in the
process (as it did in 1997), Thailand today enjoys both current
account and capital account surpluses, an appreciating exchange
rate, and more than healthy foreign currency reserves. So where is
the problem? A military coup in September 2006, subsequent
political instability and a rash of nationalistic business decisions
have harmed the investment climate. Thailand's economic growth
trails that of its neighbors and is overly dependent on exports,
which could now be harmed by a sub-prime induced slowdown in the
U.S., Thailand's chief market. The Thai economy sorely needs a
boost in domestic demand, productivity and infrastructure investment
to keep pace with competition from Vietnam and China. Planned
elections in December bring hopes of renewed political stability,
but likely will result in a weak coalition government that will be
hard pressed to provide the decisive economic leadership that
Thailand needs. END SUMMARY.

2. (U) Ten years after the 1997 financial crisis, Thailand's economy
has seen a steady, if unspectacular, recovery to sustainable growth
levels. From a low point in 1998, when GDP contracted by 10.5
percent, Thailand has averaged 5.9 percent annual real growth since
2002. Inflation is now below 2 percent, and external debt is a
manageable 32 percent of GDP (compared to over 75 percent in 1998).
Thailand recorded a current account surplus of USD 6.2 billion for
the first half of 2007. The capital account is also in surplus,
with net inflows on track to exceed the USD 8.9 billion recorded in
2006, before the recent interruption of the sub-prime mortgage
fallout. This balance of payments situation has caused the Thai
baht to appreciate 18 percent in the past 12 months, well outpacing
similar rises in other Asian currencies against the dollar (although
more in line with those currencies if measured since 2004). Foreign
reserves, once depleted during the 1997 crisis, now stand at over
$73 billion and can cover 7-8 months' worth of imports. The
government has run a balanced budget for the past two years.

A LOST YEAR
-----------

3. (U) While such macroeconomic fundamentals would normally portend
a period of healthy growth, Thai economists and investors, both
foreign and domestic, are concerned about immediate prospects.
Investor and consumer confidence indices are at ten-year lows.
Domestic demand (consumption and investment) remains virtually flat
after growing just 1 percent last year, and Thailand's growth rate
is trailing that of its neighbors. Real GDP growth is expected to
slow down to 4 percent, and possibly as low as 3.7 percent, this
year. Vietnam and China, by comparison, are expected to meet or
exceed their 8 to 10 percent annual growth from 2005 to 2007,
according to World Bank figures. Those same figures show Indonesia,
Philippines and Malaysia growing at an average of 5.5 percent
annually over 2005-07.

4. (U) Moreover, Thailand's modest growth is due almost entirely to
exports, which have risen sharply over the past 18 months. Exports,
however, appear to be finally slowing with the appreciation of the
baht making Thai goods more expensive abroad. Exports in July grew
at an annualized rate of 5.9 percent, compared to 18.6 percent for
the first six months of 2007 (although the Bank of Thailand on
August 28 tried to attribute the fall to a temporary closure of
refinery facilities for repair). Figures are likely to fall further
in coming months as demand in the U.S. - Thailand's largest export
market - continues to contract.

5. (U) Thailand's future growth in the short-to-medium term requires
a combination of political stability, enhanced productivity,
stimulated public investment (especially in infrastructure), and
increased domestic demand to take the burden off of the export
sector. So far, there are few indications of such on the horizon.
On the contrary, in the ten months since last September's coup
d'etat, the Thai government has:

BANGKOK 00004639 002.2 OF 003

-- Imposed martial law on the entire country following the September
coup, and subsequently lifting it in only 41 of the 76 provinces in
late January.

-- Put a hold on government investment expenditures, including
long-delayed "megaprojects" such as expanded mass transit lines and
provincial highway construction.

-- Imposed a 30 percent reserve requirement on most capital inflows
in December, only to remove those controls for portfolio investment
the next day following a 15 percent drop in the stock market.

-- Introduced amendments to the Foreign Business Act (FBA) that
would restrict foreign ownership in selected sectors and possibly
force foreign investors to retroactively give up majority voting
rights or divest within a given period. (This bill has been
retracted and it's future status is uncertain - see ref A.)

-- Forwarded to the National Legislative Assembly (NLA) additional
bills, including a draft Insurance Act and Retail Act, provisions of
which include measures to limit the expansion of foreign investment
in these industries.

6. (U) Rather than focus on government missteps, a number of media
pundits, exporters and economists have termed the baht's
appreciation a new "crisis" and are urging the BOT to maintain or
weaken the exchange rate by: 1) aggressively buying U.S. dollars in
currency markets and 2) sharply cutting interest rates by 1.0 to 1.5
percent. Supporters of this view claim that over 2 million
export-related jobs will be threatened if the baht breaks the Bt
32/USD barrier. Most of those jobs will be lost in labor-intensive
industries such as textiles, or producers of agricultural and
seafood products - the latter being more price sensitive than
electronics or machinery products that are vertically integrated in
foreign production chains.

7. (U) These critics dismiss the onerous task faced by the Bank of
Thailand (BOT) of soaking up dollars produced by the dual
current/capital surpluses. "Defending the currency by buying the
dollar should be easier than by selling the dollar as in 1997," said
one. "If the central bank had cut interest rates more aggressively
and earlier," he added, "it would have succeeded in maintaining baht
stability." According to this line, lower interest rates will keep
the BOT's sterilization costs low when issuing bonds to control baht
liquidity. The BOT also has positive carry on its baht debt
(earning more on its U.S. Treasury bonds than it pays out on baht
debt). As for concerns about an excessive foreign exchange buildup,
another economist said, "If anyone worried about foreign exchange
losses (through a weakened dollar), China's central bank officials
would have been executed by now."

8. (U) Other economists, who, fortunately, include those in charge
at the BOT, maintain that Thailand cannot purchase dollars
indefinitely. Besides the potentially huge foreign exchange
valuation losses accruing from a weaker dollar, Thailand's balance
sheet already includes 1 trillion baht worth of baht-denominated
debt through sterilization measures, compared to 800 billion baht of
base money. Further, Thailand does not have a government investment
corporation with which to invest the reserves (a situation that many
economists would prefer to keep, due to the temptation to take on
higher risk).
9. (U) In a July speech, BOT Deputy Governor Bandid Nijathaworn
noted these risks in addition to the difficulty of targeting the
exchange rate and inflation simultaneously. "There is a risk that
the central bank may cut interest rates too much," he said, "sowing
the seeds for inflation and an asset price boom down the road as
well." Most observers believe Finance Minister Chalongphob is in
full agreement with the BOT economists, who prefer only occasional
currency interventions to reduce volatility while encouraging more
capital outflows to relieve the surplus.
10. (U) Economist Supavud Saicheua, however, goes further, saying
that the exchange rate should be left alone: "The appreciation of
the baht must be seen for what it is: an increase in Thailand's

BANGKOK 00004639 003.2 OF 003

purchasing power, which presents us with the opportunity to buy the
many things we need from the world market." The current account
surplus, he added, "may have been essential during 1997-2004, when
Thailand had to generate excess dollars to repay foreign debt, repay
the IMF and build up international reserves lost during the 1997
crisis." Supavud bemoans Thailand's reliance on exports, noting
that the pre-1997 baht was even stronger, at Bt 25/USD, and exports
only 35 percent of GDP (compared to Bt 34/USD and 60 percent today).

11. (U) Ideally, the higher purchasing power of the baht should
allow Thailand to re-tool its production facilities, physical
infrastructure, and research and development base to prepare to
compete in coming years. It is also an opportunity for Thai
consumers to use their buying power on imported goods. However,
voices such as Supavud's are being eclipsed by the clamor for
exchange rate protection emanating from large exporters, such as
shrimp and tuna processing firms with low margins. Thirapong
Chansiri, president of the world's largest tuna cannery, Thai Union
Frozen Foods, said on August 26, "Would it really help the country
if we moved to Vietnam?" Better to maintain a favorable exchange
rate, he said. He added that "while we in the past complained about
politicians with conflicts of interest, this new government, run by
bureaucrats, isn't accomplishing anything, and I'm really desperate
about the future."

12. (SBU) While a seemingly paralyzed government and low consumer
and investor confidence continue to hold sway, optimists hope that
national elections, now scheduled for December 23 will remove enough
political uncertainty to unleash a broad growth rebound in 2008.
But those elections are likely to result in a weak coalition
government, as the August 19 constitutional referendum vote revealed
that sharp schisms remain between the Bangkok elite and the
provincial voter base of ex-PM Thaksin's disbanded Thai Rak Thai
(TRT) party (ref C).

13. (SBU) Comment: A weak democratic government will certainly be
an improvement over the current coup-installed one, but will be hard
pressed to provide decisive economic leadership in the months ahead.
An interesting aspect of the current political maneuvering is the
reappearance of ex-PM Gen. Chavalit Yongchaiyudh, angling to lead an
alliance of several new TRT-based parties. He ended his last term
as Prime Minister almost ten years ago, four months after he touched
off the 1997 crisis with his fateful but unavoidable decision to
float the baht.

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